Samsung’s predicament

In the past year, Samsung went from being a moderately successful electronics manufacturer to the leading non-iOS mobile device maker. Together, Apple and Samsung earn 98% of the profits in the smartphone market. MG Siegler echoed a common sentiment when he wrote that Samsung is now the "fifth horseman" of tech, alongside Apple, Google, Amazon, and Facebook.

The mobile device industry is still in its infancy. Samsung's fate depends largely on how the industry evolves. If the computer-in-your-pocket (smartphone/tablet) business ends up being like the computer-on-your-desk (personal computer) business, Samsung is on track to be the modern Dell. Dell had a good run as the low-cost provider in a highly commoditized business, but the vast majority of the industry profits went to Microsoft.

So the big questions for Samsung are:

1. Will the smartphone/tablet industry stratify the way the PC business did?

The dominant view is that technology markets inevitably stratify. Clay Christensen is the most sophisticated proponent of this view. In his theory (more here and here), every tech market eventually "overshoots" the needs of its customers, at which point the benefits of horizontal specialization outweigh the benefits of vertical integration.

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A minority view, held mostly by Apple faithful, is that Christensen et al are guilty of over-theorizing. Apple lost the PC business simply because, when Steve Jobs was fired, they stopped innovating. When Jobs returned, Apple started gaining PC market share again. In this view, the future mobile industry structure mostly depends on whether Apple management is innovative enough to keep making superior vertically-integrated products.

2. If the industry stratifies, will the lion's share of the profits go to the OS and application layers as it did for PCs?

Generally, technology businesses that are defensible have network effects, and network effects usually arise from products with significant software components. Samsung's competitors like HTC are just one hit product line away from stealing Samsung's position. Eventually, handset designs will converge and, as happened in the PC market, consumers will stop paying premiums for performance improvements (arguably, this has already started happening). The OS and apps layer, on the other hand, are very hard to replicate. If you invest enough money you can usually build or acquire decent software, but it takes more than just capital to build a vibrant developer ecosystem (just look at Microsoft).

Samsung's predicament is: their current strategy succeeds only in the scenario where both (a) the industry stratifies, and (b) significant profits flow to hardware. Samsung seems to understand the improbability of (b), which is why they've been hinting at throwing serious support behind a new OS. Getting traction with a new OS will be difficult, to put it mildly. Google and Apple have vastly more experience making software and a huge head start with developers. Moreover, Google's strategic position is even stronger today than Microsoft's was in their heyday. Google makes so much money from web services (mostly search, for now) that they can afford to lose money on handsets and OSs indefinitely - a very scary fact for Samsung and everyone else in the mobile hardware business.